Badger Meter Inc (BMI) 2007 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Badger Meter, Inc.

second-quarter conference call.

Today's call is being recorded.

The call will be available for replay on Badger Meter's Web site.

Joining us today are Rich Meeusen, Chairman, President and CEO, and Rick Johnson, Senior Vice President, Finance, Chief Financial Officer and Treasurer.

At this time I would now like to turn the call over to Mr.

Johnson.

Please go ahead sir.

Thank you very much, and welcome, everybody, to our 2007 second-quarter conference call, which is the first conference call in Badger Meter's 100-year-plus history.

With the growing interest in water in general, and Badger Meter in particular, we have been spending increased amounts of time each quarter answering what we determine to be very similar questions from many of you.

As such, we thought it was time for Badger to address investors on a quarterly basis and attempt to answer your questions in this format.

So I want to thank all of you for joining us this morning.

Many of you know Badger Meter and how we operate.

We will make every attempt to answer your questions.

But as you know, we have certain guidelines on what we comment on, and those won't change here.

For competitive reasons we do not comment on specific individual product line profitability, nor do we disclose components of process sales, for example, copper.

Most importantly, we will continue our practice of not providing specific guidance on future earnings.

We continue to believe guidance does not serve the long-term interests of our shareholders.

I will begin by stating that we will make a number of forward-looking statements on our call today.

Certain statements contained in this presentation, as well as other information provided from time to time by the Company or its employees, may contain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements.

Please see our 2006 Form 10-K for a list of words or expressions that identify such statements, and the associated risk factors.

With that behind us, let's talk about our results.

Yesterday afternoon after the market closed, we released our second quarter 2007 results.

We are pleased to report that sales were a record $62.2 million, an increase of 5.7% over last year's second-quarter sales of 58.8 million.

We will talk more specifics in a minute, but I can tell you that the sales increase was driven primarily by sales of ORION automatic meter reading products.

Most of you know our sales are generally an 80/20 split between utility and industrial products.

The second quarter of 2007 continued to fit this mold, with residential and commercial water meters representing 80.6% of total sales for the quarter.

These sales increased $2.8 million to 50.1 million compared to 47.3 million in the same period in 2006.

The primary driver of this increase, as I noted, was the increased sales of ORION products.

It was offset somewhat by lower sales of local read and commercial meters.

For the second quarter, ORION sales were nearly 56% higher than the second quarter of last year.

Sales of our products with the Itron technology declined nearly 30% compared to the same period last year.

Industrial sales for the quarter were 4.3% higher than last year, with automotive fluid meters and impeller meters showing the biggest increases, offset somewhat by decreases in sales of electromagnetic meters and valve products.

Gross margins for the second quarter were 36.2% compared to 35% last year.

The increase was due to the increased sales that I just referred to, as well as the impact of price increases put into effect last summer.

Negating some of this improvement is continued cost increases on purchased components, due to increased prices of raw materials, particularly copper.

Another price increase was put into effect on July 1st of this year, which is intended to continue to recover the increased cost of our products.

We are also seeing cost savings from a new facility in Nogales, Mexico, which replaced our facility in Rio Rico, Arizona.

Our selling, engineering and administration cost of 13.1 million for the quarter was higher than last year's amount of 11.9 million, and was also slightly higher as a percentage of net sales when that comparison is made.

In this quarter we had higher legal fees associated with recently completed successful litigation, some higher incentives due to improved results, and some slight increases in our reserve for doubtful accounts.

There are also normal inflationary increases; however, we are continuing our cost containment efforts.

The effective tax rate for this quarter was 37.1%, slightly lower than last year's amount.

We believe this is a reasonable estimate for the year as a whole.

When all of this is taken together, our earnings from continuing operations for the second quarter were 5.7 million compared to 5.1 million last year.

Like our sales results, this is also a record for Badger Meter in any quarter of our history.

On a diluted basis, earnings per share from continuing operations were $0.39 this year compared to $0.35 for the same period in 2006.

With regard to our financial condition, there are really no significant changes on our balance sheet other than increased receivables since year-end.

Given the seasonality of our business, particularly after the fourth quarter last year, this increase is expected and is consistent with past practice.

Our debt as a percentage of total capitalization is approximately 24%.

As you can see on our balance sheet, we had more cash than normal at June 30th.

This was just simply a function of the timing of various cash receipts.

With regard to cash flows, you'll find that we generated substantially more cash in the first six months of 2007 versus the first six months of 2006.

Items of note on cash flow include the fact that we received a refund of from the IRS of all taxes paid for 2006 as a result of a tax position that we are taking with regard to the discontinuation of our French operations.

That amount was in excess of $6 million and is fully reserved until the ultimate resolution of the issue.

When you look at our investing activities, you'll find that our capital expenditures on a year-to-date basis are (inaudible) than last year at this time.

The reason for this is that we've begun to fund the construction of the second phase of our Mexican plant expansion, for which we recently broke ground.

And finally, you'll see proceeds from the sale of our French assets, notably the building.

With that I will now turn the call over to our CEO, Rich Meeusen, to talk about Badger Meter's short-term and long-term strategies.

Thank you, Rick.

I'd also like to welcome all of you to our first conference call, and thank you for joining us.

Let me begin by saying that we are, obviously, pleased with the results for this quarter, but also remind you that our business tends to be difficult to predict on a quarter-to-quarter basis.

Decisions by a few large customers to accelerate or delay shipments at any quarter-end can have a significant impact on our short-term results.

While our second quarter is a little more typical of what we expect, you should bear in mind that one quarter does not reflect a trend in our business.

Our management team has always been and will continue to be focused on long-term results, as opposed to being focused on meeting quarterly expectations.

Having said that, let me also say that we are optimistic about both the current year and the long-term prospects for Badger Meter, especially in light of the recently announced Chicago contract, which I will elaborate on a little more in a minute.

Even without the Chicago contract, though, the demand for our ORION automatic meter reading system remains very strong.

We recently strengthened this product line with the introduction of a new ORION connectivity product called the ORION Gateway System, which permits the ORION radio transmitters to communicate with a wide array of public wireless network systems sold by our alliance partners, such as municipal WiFi or cellular networks.

This is an important feature for many utilities as they look for ways to easily migrate from mobile to network systems.

Although the high cost of copper continues to be a concern, as Rick mentioned, we have been successful in passing on most of those costs through last year's price increases and through another increase announced July 1st.

We continue to invest aggressively in our R&D programs, both for utility and industrial products.

In addition to the new ORION Gateway product, last month we introduced a new residential water meter called the Lo-Profile meter.

This water meter exceeds AWWA standards and has the same accuracy and long life as our standard meter, but does so in a smaller body that uses one-third less copper and allows our customers to install the meter in shallower pit boxes or tighter basements spaces.

Transitioning our customer base to this new meter will reduce our exposure to future copper fluctuations.

Looking at products in the pipeline, we are developing new versions of ORION, as well as investing in new features for our GALAXY fixed network system, which we believe is a superior product for those utilities that want their own dedicated fixed network system.

Now let me make a couple comments on the Chicago contract that we announced last week.

As you know from the press release, this is expected to be a three-year project for approximately $40 million.

This amount includes $24 million for meters and the ORION radio system, and $16 million for installation labor, which we have subcontracted out.

Although we will not disclose the specific margins for this project, I will say that we expect the $24 million product portion to have margins approximately equal to our normal ORION margins.

However, since the 16 million installation contract is a pass-through to the subcontractor, we have very little margin on that portion.

Also, the majority of the meters in Chicago will be Badger's plastic meters, which Chicago has used for many years.

Obviously, those meters are not subject to the impacts of copper price fluctuations.

Regarding timing on the Chicago contract, we expect to start a one-month pilot installation in August, with regular shipments beginning sometime in the fourth quarter.

I think it's also important to note that this contract is to install ORION on 162,000 of the city's water services.

That leaves over 325,000 services that are still unmetered in Chicago.

We believe that there's a good probability that the city will continue to roll out the ORION system as it moves forward with additional metering beyond the three-year contract.

Finally, I want to point out that although we have sold ORION to over 900 utilities, Chicago is the first large city to adopt this system.

We believe that this success now positions us to aggressively deploy ORION in more large cities in the future.

Badger is positioned at the nexus of two very dynamic markets, water and AMR, and we continue to hold our position as the leading provider of AMR products to the U.S.

water industry.

We believe that we have the best products and the best brand to take advantage of the growth opportunities in the industry.

That concludes our prepared remarks, and at this time we're willing to take any questions you may have.

(OPERATOR INSTRUCTIONS).

John Quealy, Canaccord Adams.

Congratulations on the quarter.

Rick, first for you, a housekeeping item.

You went through some numbers pretty quickly.

In terms of ORION product year-on-year, I got the Itron number.

I think you said Itron was down 30% year-on-year.

What was ORION up year-on-year?

First of all, Q2 over Q2, ORION sales were 56% higher Q2 of '07 than Q2 of '06.

Itron sales declined nearly 30% Q2 over Q2.

Perfect.

Rich, you talked about plastic a lot here.

Chicago is buying it in a big way.

And it's really the first time we've heard you come out hard on it.

Can you go through a little bit on the strategy of it?

Is this going to be a major focus for you folks moving forward, clearly, with a nice marquee customer here to launch it off?

We've been selling plastic meters for about 20 years.

And it really hasn't taken off well in the industry, even though the plastic meters we sell have the same life, the same accuracy, the same warranty as our brass meters.

There's just been a perception in the marketplace that plastic wasn't as good as brass, and that's been a headwind on it.

Historically we've averaged about 7 or 8% of the meters we've sold being plastic.

For the first six months of this year, that's jumped to about 15%.

So even without Chicago, we've seen a jump in the plastic.

I think it's a response to the higher copper costs that we have in the marketplace.

There's also a concern about vandalism, and people are buying the plastic meters for that reason.

With Chicago taking on the plastic meters, I think we have an even greater opportunity to really push these out into the market.

It's a great product line, and I would like to see more use of it.

In terms of your competitive positioning as you go, again, Chicago is the first big order in quite sometime on that scale, are you planning on going in with more of a plastic bent into these?

And secondly, on the manufacturing side, if 15% of the business is running plastic, what's the ability on the throughput side to deliver that?

We have plenty of capacity for the plastic, especially given the fact that the change we made last year where we constructed the first phase of our plant in Nogales, and we closed our Arizona plastic molding facility; that gave us additional capacity for doing plastic, anticipating that this might happen.

So we're not concerned about a capacity issue.

I think we have plenty of capacity to increase as plastic goes on.

And I think we're seeing more interest by our sales force in pushing plastic, and more acceptance by the customers.

My final question, Rich, more strategic.

On the marketplace, we saw Itron with Actaris this year close the acquisition, and presumably at some point migrate to the States in a bigger way in water.

Obviously, Roper has been a tough competitor and will continue to be.

I'd like to hear your thoughts on what the competitive landscape is looking like in the near-term and the long-term for you?

And then, on the back of that, what are you thinking about M&A as you move forward?

Thanks.

Let me start with the competitive landscape.

Actaris -- Itron's purchase of Actaris, we don't believe, will have a significant near-term impact on our market position.

Actaris has a U.S.

gas metering presence and a strong international electric gas and water metering presence, but they really don't have a significant position in the U.S.

water meter market at this time.

And to our knowledge, they don't have a full line of water meters that meet U.S.

standards, particularly in positive displacement metering, which is the most common type of meter sold in the U.S.

Now, having said that, it doesn't mean Actaris couldn't develop and introduce those meters in the future, but we just haven't seen it to this stage.

As far as Roper, Neptune continues to be a great competitor.

They're a strong company.

They do very well.

And we compete head-on with them in the marketplace, and I think we will continue to.

On the second part of your question, acquisitions, we are continuing to pursue small strategic acquisitions, particularly in the industrial flow area.

This has been difficult recently due to the amount of private equity money that's chasing limited opportunities.

We all know about that.

And of course that translates into higher multiples being paid.

However, we are continuing to look for those opportunities where we can leverage our flow technologies and our brand name in the market.

Regarding larger acquisitions in water or the AMR segments, we don't see any major opportunities that would be an appropriate for us at this time.

However, we are open to exploring anything that might come along.

That's really all I can say.

Richard Eastman, Robert W.

Baird.

I wanted to go back a second as well on the numbers that you tossed out, Rick.

The local read business then, did you suggest it was down, as well as commercial was down?

Yes.

So that's down.

Commercial's down.

And then the -- can you give us a sense of the price realization in the quarter?

When you look at the year-over-year, when you look at the sales line, your sales were up 5 to almost 6%.

What do you think was the price realization there?

I would say that we know that cost increase is driving some of it.

We got most of the cost increase, so I would say a good chunk of this increase -- this is, obviously, volume driven also.

But we also got most of the price increase, and they're covering those costs.

Again, we can all do our own math at the cost of sales line in terms of what copper did to your cost of sales.

But if I just look at sales year-over-year, did we get 3 to 5% price increase?

Yes.

I'd say that's fair.

I'd say volume and price -- it's equal match.

And then the other question would be, on July 1st, what did we raise prices there on kind of a blended basis?

We're not disclosing that.

As consistent with prior meetings, we don't talk about that.

Let me ask you.

The incremental margin, gross margin, in the quarter, really, I'm thinking first quarter to second quarter, not year-over-year.

First quarter to second quarter, the incremental gross margin was like 66%.

Now, I can kind of look at ORION and see the mix, obviously, was quite favorable.

But is there anything else going on in there that drove that incremental margin higher?

Was price realization in the second quarter better than it was in the first quarter with shipping cycles, or --?

I think as a general comment, you could say price realization is better in the second quarter, simply because it's been in place longer and we're realizing more of that.

But really, one of the primary drivers was the ORION sales.

As we look forward, how should we think about the gross profit margin?

And again, let's just leave Chicago out of this, because it won't be much of a factor.

In the second half versus the first half, should we be looking at kind of a year-to-date gross margin versus the second quarter being sustainable?

How should we think of that number?

That's an interesting question.

I think the realistic answer is we've said all along, our quarters can be lumpy and a lot of it is due to the mix.

Quite frankly, we don't have great visibility into the product mix looking out at any point in time.

You know from disclosures, for instance, that we make at year-end, at best we know half a quarter's backlog at a point in time.

And so the realistic answer is if we did some orders in there for an Itron mix or a local read mix, it could impact it.

So it's hard to generalize about what's going to happen going forward.

Obviously, the price increases will help, and we say we're optimistic about that.

But it's hard for me to give you any kind of short-term guidance.

Rick, can you just give us a dollar figure for your operating income in the quarter?

Sure.

Operating earnings for the three months ended June 30, 2007, $9.4 million.

Excellent.

Maybe one last question.

Rich, on the Chicago water business, I know we'll start this up; we'll fire this project up in the fourth quarter.

Is there any lumpiness to the three-year kind of expected shipping cycle?

It's not like half of this comes in in the first year and trails off.

Or should we just kind of straight-line this project into '08, '09 and part of '10?

All of the indications we have from Chicago are that they intend to do a fairly steady deployment.

But that having been said, what we've learned in this business is that it doesn't always work out that way.

Frankly, when the snow starts blowing, starts falling in the winter, it might slow it down a little bit.

So you might see some first-quarter drop-off.

Look at our experience with Houston.

We believed that Houston was going to do their entire change-out in two years, and it took five.

So you never know what's really going to happen.

But the indications we have from Chicago are that they intend to do a fairly steady deployment over the three years.

Maybe one last question.

On the plastic meters that we talked about, and maybe gaining as a percentage of sales, would your gross margin on those meters versus the brass meters -- would it be higher?

I know it's less volatile, but would it be higher or lower?

Obviously, it depends upon the cost of copper.

But right now, with copper and alloys where they are, it is higher.

Ryan Connors, Boenning & Scattergood.

A few questions.

First of all, just more of a short-term thing.

Obviously, you touched on the impact of pricing on gross margins.

But also, copper clearly took a dip down there.

Kind of late '06, early '07, it went from that $3.50, $4 range where it is now, and it kind of dipped $2.50 and below for a while there.

Is some of what we're seeing on the gross margin line this quarter kind of some of that cheaper inventory in terms of copper rolling through the P&L, or is that not the way to think about it?

We [didn't] see a lot of cheaper copper coming through the inventory.

It may have been a little bit early in the quarter, but I wouldn't say it was a big impact.

Another thing you have to realize is that first off, like I said, about 15% of our sales have been plastic, so copper doesn't affect that.

Also, we have a percentage of our sales that are non-leaded brass, and non-leaded brass uses virgin copper.

But the vast majority of our brass sales is from scrap copper.

And sometimes the scrap index doesn't follow the copper index.

You'll find that the scrap is obviously cheaper, and the spread between the two can narrow or widen as the years go on.

We actually saw it narrow when copper dropped, and we tend to see it widen when copper goes up.

So scrap tends to be a little more stable than what we see virgin copper doing.

So there isn't necessarily a 1-to-1 correlation, where you can say this is what copper is selling for, and therefore, this should be Badger's cost.

It's a little more complicated than that.

Secondly, in terms of pricing, I wonder if you could just comment on, first of all, in the short-term, whether you're still seeing good acceptance generally on your pricing initiatives, and in particular, any early signs on the July price increase.

And then just more generally, are you really starting to see a shift now in the utilities, whereas before they might look for year-over-year declines in meter prices, to where your customer base generally is now kind of in a different mindset, where they just kind of realize that higher prices are going to be a reality?

I think there's no question that over the last decade, our industry has created an expectation among the customer group that they can get cheaper products every year.

And that was a problem, and that was having a negative impact on all of our margins.

With the high price of not just copper, but with oil affecting plastic resins, and a lot of other factors, glass, things of that sort, I think starting last year we were able to kind of break that mold and convince the customers that there have to be some price increases.

So we had our price increase last year.

We felt it came out with very good acceptance.

We were actually very pleased with it.

This year we did another increase, a smaller increase on July 1st, and we are not seeing much push-back on that either.

Now, there's still a lot of customers that are purely on a bid basis, where everybody is out there competing on bids, and anything can happen in that situation.

But generally, I would say we're seeing pretty good acceptance in the pricing.

Just touching back on Chicago real quick, did you get any feedback from the city in terms of what it was about the ORION product that -- what they liked about it, why they chose to stay with you guys?

It's obvious.

They liked it because it's the best product in the market.

No; there were several things about ORION they liked.

First off, the city did some very extensive testing, where they took our products and competitive products, and put them into a lot of their buildings.

And you know, Chicago has sub-basements, where the water meter may be two or three stories below ground level.

And they were very interested to see what kind of performance that had when they drove by at street level and tried to read those meters.

So first off, they liked the performance of the meters because we were getting signals out of those sub-basements that a lot of our competitive products weren't able to do.

They also liked the fact that the ORION product has upward -- it has upgradability to various network systems through the connectivity systems and through our connectivity partner.

That was very important to them also.

And then we also have a repeater product that if you really get into a hard-to-read position, and it's hard to get a signal out of there, we have a small product that's both a receiver and a transmitter that will repeat the ORION signal, and in those situations they can use that.

And I would say all of those were very key.

And then the fact that the City of Chicago has used our Badger plastic meters in the past; they like them, and that helped us, too.

That's very, very helpful.

Thanks for all the detail.

Brian Rafn, Morgan Dempsey Capital.

Can you give us a sense -- the impact -- we always talk about copper prices on the brass -- as you guys roll into the plastics, what the impact on oil prices and resins has been, say, over the last couple of years?

Again, we don't talk specific products, Brian; you know that.

But you don't have to be a rocket scientist to know that the price of resin has gone up.

So it's influenced the cost of plastic meters, not to the extent, for instance, that copper has on the brass meters.

But it has had an effect.

Beyond that, we really don't comment much on that.

Would you be able to -- do you think the market from an elasticity standpoint, if we continue to see oil rising, say, over $100 a barrel, do you think you have the price realization ability to pass on oil resin inflation as you do on the copper side?

I believe we do.

Unlike the brass, the resin is not as large a component of the product as the brass is.

Because when you get into the plastic molding, you're doing a lot more machining of the product.

There's a lot more added value in there.

But I think there's plenty of room in the marketplace, especially considering the alternative is brass, and where the cost of brass is today.

Right.

The way you guys source the brass castings from Fall River, what are you guys doing as far as the plastic?

Are those fabricating and machining yourself, or are you getting those sourced from a third party?

That's entirely done by ourselves, and that's what we built the first phase of our Nogales facility for.

We had been doing it in a smaller facility in Rio Rico, Arizona, which we closed last year, and we shifted over to Nogales.

And we do that all in-house.

Can you give us a sense what you might think today, what your unit volume capacity in plastic might be today?

I would say today we could probably do 2 to 300,000 units a year.

And then that will ramp up as you go forward?

Correct.

What from the standpoint -- do you guys sense what some of these other major cities that just come -- as they come, their sensitivity to cost and the usage of plastic?

Obviously -- do you see a lot of follow-on with Chicago?

Or do you see a period of time where they're going to sit back and wait and watch for a couple of years as Chicago installs this?

That's an interesting question.

One thing that Rich didn't mention about Chicago is the fact that they started installing plastic meters almost from the get-go, so to speak, because they never had meters before.

So we weren't fighting that perception problem with Chicago.

And that's one of the reasons, I think, they went to it.

I think that perception problem, as Rich mentioned it being a headwind, I think that will continue for a while.

We thought maybe we'd see more migration to plastic last year.

We saw a small amount when copper hit $4 a pound almost.

So I don't know the breaking point, at what point somebody is going to say, well, regardless of how it is perceived, it's now time to look at plastic.

That's a tough one to answer and I don't think we have an answer at this point.

Just for our edification, how long has Chicago been using plastic?

Probably almost 20 years, which we introduced plastic in, I believe, the early '80s.

So almost from the start.

That's fair.

Can you tell us what -- and I'm assuming this 162,000 units is just for the City of Chicago proper, population 18, 19, 20 million, whatever it is.

What's the sense in the suburbs?

You guys have certainly [done a lot of pilot to serve] Milwaukee Metro with Brown Deer and that.

How are the other suburbs tied in on a water basis to the City of Chicago?

I think some of the suburbs use Chicago water where they can draw it from the Great Lakes Basin and return it to the Basin, because there is a Great Lakes compact that gets a little complicated about who can and can't use it.

But the suburbs all make their own buying decisions.

We have several of the suburbs that are our customers.

Several of them buy from competitive products.

But I don't see where Chicago -- I guess what I'm saying is Chicago making this decision does not necessarily mean all of the suburbs will adopt the same decision.

The suburbs tend to go their own way.

How much -- the genesis of this acceptance.

How much visibility was given to you guys?

Did you guys get a sense that -- I've asked Rick this question ad nauseum.

Was it just a phone call one morning and bang, there it was?

Or did you get a sense that there was a month or two where things were starting to percolate?

I'm just kind of wondering how much visibility you guys have (multiple speakers)

You're talking about the Chicago contract?

Yes, Chicago.

About two years of visibility.

Realistically, we started working on the Chicago contract two years ago.

I believe it was St.

Patrick's Day of '06 when we all -- we and our competitors all submitted our bids into Chicago.

And it's taken almost a year and a half for us to get the contract finalized on Chicago.

But this is the sort of thing where we knew that we were the preferred bidder probably six months ago, and then it was a matter of working through all of the contract issues.

Okay.

The liquidation of the French operations, Rick, is that finalized pretty much?

Finalized is maybe too strong a word, but it is clearly winding down.

And I suspect by year-end we will have little to no discontinued assets or liabilities.

There are no employees left; there's no building left; there's no operations going on.

There are some receivables being collected and some payables being paid off.

That's really about it.

Can you give us a sense as -- you talked about the second phase of Nogales -- the timeline, size of the project, dollars, when it will be finished?

The second phase, we've broken ground recently.

We expect to be done by the middle of next year, and we're looking at doing about 120,000 square feet down there.

That will be the size of the facility.

We have a 60,000 square foot facility down there that we are leasing right now.

And so when the facility is done, we will move those operations into the new building and terminate the lease.

And what is our total estimated cost on the facility, Rick?

A little over $10 million.

And we have funded some of that money already.

And again, you'll see it in the cash flow under capital expenditures.

Specifically, is that assembly of plastic meters?

What specifically are you installing into (multiple speakers)

The plastic meters are being done down in the first phase building.

This is all the registration and radios.

This is the potting of the radios, the assembly of the registers that go on top of the meters, the sealing of the registers -- that kind of operation.

What do you guys get a sense on as far as total AMR in the market, both the infield installation that exists today, as well as the installation rates that are happening here in '07?

I think first of all, it's getting more and more difficult to get that.

Because some of what we're shipping now as AMR is actually replacing the original stuff from the early to mid '90s.

That's why we estimate 20 to 25% of the market is converted to AMR.

Of what we're shipping now, we generally say about half go out with radios and half don't.

And if you follow that -- the other thing we've always said historically is on average, they're changed out every 15 years.

If you follow -- if we're at the 50% level for the next 15 years, the market will be half converted by then.

One final little housekeeping.

You gave us some guidance on tax, Rick.

I know you're not going to give us any earnings guidance.

How about property, plant and equipment budget for the year?

I think it's going to be -- the capital expenditures are going to be higher than last year simply because of phase two of Mexico.

And beyond that, it's probably in the normal type range of CapEx.

And you were doing something in Germany, weren't you, too?

Germany for the most part is in the numbers already for the first half of the year when you see those.

Swell job, guys.

Thanks.

Richard Eastman, Robert W.

Baird.

Just as a follow-up, did some of the strengths that we experienced in the second quarter, was some of that delayed shipments from the first quarter in ORION?

Because we had a very soft first quarter.

And I'm just curious, again, should we be thinking that a year-to-date growth rate is more reasonable for ORION?

What I would say is there were some shipments at the very end of the first quarter that didn't go out at the customer's request, went out in early in the second quarter.

I wouldn't say it was a large impact, but it had some impact.

Now, I also wouldn't say that you can then say, well, the first quarter was unusually weak, the second quarter was unusually strong, so the right answer is an average between the two.

As I said in my opening comments, this is a lumpy business.

It's very hard to verdict what the right average is.

And I know that's your job and that's what you're trying to do.

But I would say that we had some impact.

But generally, we're seeing just good strength in the market.

We really are.

Also, we've got a number of partnerships out on the power line side, and now we talk about this Gateway product with WiFi and cellular networks.

Are we seeing much actual pullthrough from these partners in terms of demand in shipments, or is a lot of this still being piloted?

Because it seems like, again, obviously, Chicago was a pure ORION win.

But I'm curious if we're seeing anything pulled through at this point or orders from some of these, I guess I would call them, alliance partners.

I'd say the answer to that is probably not a lot.

I think it's more to address the concerns that some of the customers have that if something were to come along, they want to be able to not have stranded assets.

So the reality is there's no direct partnerships.

If you saw this morning's paper here in Milwaukee, where they talked about the WiFi system is now being delayed again.

Now there's a question as to whether it'll ever be built.

I think the point of the matter is our message all along is, to the extent some of these systems do come to fruition, you won't have stranded assets you'll be able to migrate.

But the reality is there's not a lot of that out there at this point.

But having said that, we have had some successes with our alliances with Hunt, and with DCSI, the subsidiary of ESCO.

And we have several opportunities that we're pursuing with those companies.

We're very excited about them.

Any measurable traction yet in terms of orders and shipments on GALAXY?

We have several cities where we have installed GALAXY, small cities that we can now use as reference accounts.

That's helping us a lot.

And we have several what I would call medium-sized cities where we have bids in the process.

Was there any -- did we bid Chicago with that option at all?

Yes.

Chicago wanted a -- in their RFP wanted a network bid just for about 11 square blocks in Downtown Chicago, because they were concerned that a drive-by system would not be able to deal with some of the high-rises and the sub-basements and all of that.

So we bid it that way, and so did a lot of our competitors.

When Chicago made their final decision, based on the performance of ORION, they felt that they didn't need to put a network in down there, and they went with the ORION solution.

Excellent.

Thanks again.

Patrick Forkin, Tejas Securities.

My questions have been answered.

Congratulations on a great quarter.

(OPERATOR INSTRUCTIONS).

Steven Karpel, Credit Suisse.

It's Tom Klamka from Credit Suisse.

Can you talk a bit about your technology costs?

It seems like this is sort of an industry where one of the companies introduces a new technology, and it's leading edge.

And then, whatever, six months later someone else introduces one.

I guess it's constantly evolving.

It's really more of a tech-type product.

What do you see as the lifecycle for your current platforms, and where are they?

I guess with the ORION, where do you sort of rank out as far as leading-edge or not versus like, say, Itron or Sensus or these other guys?

First, Tom, I love your question.

Because for about 90 years of our company history, we were selling mechanical devices, and nobody ever called us a tech company, even though we felt there was a lot of technology in flow.

And I think we are -- people are recognizing that we are more of a tech company, and more of a company that has to invest in R&D.

Our R&D investment we run about 5 to $7 million a year, in that range.

It fluctuates up and down.

We are able to leverage to a great extent on our R&D by partnering with other companies, not competitors.

In the case of ORION we partnered with a German company.

In the case of one of our registers, the ADE, we partnered with a Swiss company.

In the case of GALAXY we partnered with an Israeli company.

So very often, because Badger doesn't sell in Europe and doesn't compete over there, we can make these partnerships and keep our R&D spending under control, and also bring the products to market a lot faster.

The other thing I want to say in response to your question is that things are speeding up on us.

It used to be when you were selling water meters, two to three years of development time was not unusual for a product that was expected to last 20 years in the field.

With electronics, with technology, the development times are compressing.

And we're really in a mode now where we are looking at introducing new versions of ORION probably every 18 months, 18 to 24 months, somewhere in that timeframe.

So we have just recently introduced ORION 2.

We are in the process of working on ORION 3, and we'll continue to invest.

Same thing with GALAXY.

The network systems are changing so quickly that by the time you get your product done, there's something new in the marketplace.

So we're working into one of these modes of constant investment into our products to be able to stay on top of things.

The life of the product is still 20 years very often, because when the customer puts a water meter in the ground, they really don't want to revisit it for about 20 years.

The average life is 15, but we shoot for 20.

And so even with the radios, that is the life of the radio.

But you can't introduce one radio and then 15 years later introduce a new version of it.

The market expects a much faster turnover of technology than that.

And when you're out -- yes, right.

Because the product in the ground will last that long, but as far as being out marketing to customers, I would guess, given the changes in the product benefits, they're constantly looking for the latest product, the latest technology, the most innovative meter.

That's absolutely correct, Tom.

Do you see -- because of this increased frequency of sort of upgrades, do you see your -- have that having any kind of negative impact on your margins, because the technology spend will keep going up every year?

Or --?

No.

I think (multiple speakers) one of the things is each time we do a new version, generally, the chip sets and the electronics have come down in price, if anything.

And we're finding ways to do the products and take cost out of the product.

So that's actually a plus to us.

Also, we do tend to add features.

In the water industry, data profiling is important, leak detection is important, tamper detection is important.

So we're constantly adding features, and also at the same time finding ways to take cost out of the product.

You may have addressed this, but what impact are you seeing from what's going on on the housing starts?

Housing starts I did not address.

It's an interesting question that I get from a lot of people.

A lot of people are under the mistaken impression that housing starts have a major impact on our sales.

And the fact is historically, we've seen little or no correlation between housing starts and sales.

And I'll give you some numbers to support that.

Housing starts in the U.S.

have averaged about 1.7 million houses per year for the past decade.

And since about 60% of all new homes have meters in them, we estimate that about 1 million meters a year are sold for new housing each year.

Badger has about 28% market share, so this translates to about 280,000 meters per year for Badger that are sold into new houses, or about 17% of our unit sales.

So while two-thirds of our business is meter replacement, the other third is not new housing.

Only 17% is new housing.

The balance is a combination of metering existing homes that didn't have meters, or early replacement of meters due to AMR adoption.

And then, let me go on and make one more comment about housing starts because I think it's important.

People ask me about our sensitivity to new housing.

Let me just say if the housing market at worst slows down to, let's say, 1.2 million meters -- houses per year instead of 1.7, which would be a disastrous year in housing, this could represent a decrease of about 80,000 meters per year for Badger, or about 5% of our sales.

So kind of our worst-case scenario is if the housing market really tanks, we could see about a 5% volume decrease.

But historically, we haven't seen that, because we've seen counterbalancing impacts.

In the periods when housing slows down, a lot of our municipal customers change their focus from metering new housing to changing out old meters, and that tends to help us maintain our sales levels.

That's why we really haven't seen this correlation between housing starts and our sales historically.

That's a very comprehensive answer.

Thank you very much.

I was ready for it.

Brian Rafn, Morgan Dempsey Capital.

A question on the -- you guys talked about the scrap costs.

I think you guys mentioned that you use automotive radiators.

What is kind of the all-in cost recovering that scrap, processing it?

What is kind of vis-a-vis you talk about the spread versus virgin?

I think right now, 81 brass.

That's what we use.

It's 81% copper.

We use that.

Our competitors use it.

Everybody uses it.

That brass that's made out of scrap -- and a lot of that scrap comes from car radiators, and also from old meters that are taken out and melted down -- that spread is probably about anywhere from $1 a pound -- $0.50 a pound to $1 a pound, in that range.

And it can fluctuate.

There are times when it closes up.

So if copper is at $3.50 right now, we may see scrap -- the scrap costs down around $2.50 to $3, something like that.

Okay.

And I'm assuming that you don't have any constraints, but correct me if I'm wrong.

You source some of your radios out of Diehl out of Germany.

Any constraints in capacities on the radio as you kind of continue to develop the AMR?

Diehl is a EUR2.5 billion company, and they do a lot of electronics work.

They have no capacity constraints at all for providing us with radios.

And as the cycle times compress, shipping and that type of thing, leadtimes, that's not an issue?

No, it really isn't.

We have very good supply chain management, and we've had no problems at all.

Anything on -- give us an update.

We've kind of exited the whole Gulf of Mexico, Katrina.

Anything on New Orleans as a city?

We have not seen a lot of work down there to date.

We have our salespeople down there talking to the cities.

There have been some bids, but nothing has really started at this point.

Thanks.

One more; excuse me.

You guys have talked in the past, Rich, about kind of a low-end economy meter.

That's not the plastic meter.

I want to make sure I don't get that.

You're trying to take out about 2 or $3 in cost.

Is that the plastic meter you're talking about, or are we talking about another product?

No, Brian.

That's the Lo-Profile meter that we just introduced.

It uses about one-third less copper.

Sounds good.

Thanks.

There appears to be no further questions at this time.

I would now like to turn the call over to Mr.

Rich Meeusen for any closing comments.

I just want to take this chance to thank everybody for joining us today for our first conference call and for your interest in Badger Meter.

I hope you put up with us, because this was our first time through this and we are learning as we go.

But we will be doing these calls on a regular basis, and I hope you'll join us again in the future.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect, and have a wonderful day.